Headlines – Week of August 21, 2011

According to Fitch Ratings, delinquent loans in commercial mortgage backed securities hit a record in July 2011.

The agency noted that $3 billion in new delinquencies outpaced the $1.4 billion in resolutions made on CMBS loans during that period.

This pushed the delinquency rate to 9.01% from 8.64% in June and higher than the previous record of 8.81% in May.

Fitch is still standing by their prediction that delinquencies will be up to 10% by year end 2011.

New York-based Trepp LLC also reported their information stating that CMBS delinquencies reached 9.88% in July, the highest delinquency rate in the history of the CMBS market.

One of the reasons for the increase are new reporting standards implemented by some special servicers For example, if a special servicer is considering a possible loan modification, it is now standard practice for the servicer to also simultaneously initiate the foreclosure process to expedite matters in the event that the modification doesn’t occur.

According to Trepp, this “dual tracking” approach, which includes foreclosure as a workout strategy, drives up the delinquency rate.

Among other highlights from Trepp’s report on the performance of the CMBS market in July:

The percentage of loans seriously delinquent, defined as 60 days or more past due, rose 39 basis points over the prior month to 9.14%.

The delinquency rate for office loans 30 days or more past due spiked 82 basis points to reach 8.17%, breaking the 8% threshold for the first time (see chart below).

The hotel delinquency rate soared 117 basis points to reach 15.04%.

The industrial sector was the only property type to experience a decline in the delinquency rate, falling 59 basis points to 11.09%.

The multifamily sector remains the worst performing property type on the CMBS front with a delinquency rate at nearly 17%.

Bank Failures Up in July

July’s 13 bank failures tied April’s count for the highest monthly figure since July 2010, bringing total bank failures this year to 61 as commercial real estate exposure continued to weigh heavily on troubled banks.

Bank failures to date put the annualized pace at about 100 for the full year, still well below the 157 banks that failed in 2010 and the 140 that failed in 2009.

According to Trepp, Inc, commercial real estate exposure was the main driver behind problem loans for the 13 banks that failed. Commercial real estate loans comprised $797 million, or 77%, of the total. $1.03 billion in nonperforming loans at the failed banks. Construction and land loans made up $480 million, or 47%, of the total, while commercial mortgages comprised $317 million, or 31%, of the total nonperforming pool.

The residential real estate loans were second, with $161 million in nonperforming loans, or 16% of the total nonperforming balance.

Three failures for July occurred in both Florida and Colorado. Florida ranks second for bank failures overall, with nine so far this year and 54 since the failure cycle began in late 2007.

Two failures occurred in Georgia, which continues to lead the country in bank failures, with 16 this year and 68 since the cycle started in 2007.

The largest failed bank was Integra Bank in Indiana, with $2.2 billion in assets. The closure was the first in Indiana this year and only the second since 2007.

All the banks that failed in July had been on the Trepp watch list for four to 11 quarters.

Twenty-five percent of all U.S. banks do not meet the minimum risk-based 8% Tier 1 capital requirement, according to a recent two-year stress test completed by financial risk management firm Invictus Group.

The test shows 1,983 out of 7,695 banks would be challenged capital-wise in times of stress.

Is the Era of “Extend & Pretend” Over?

According to industry experts, the era of “extend and pretend” may be over as lenders and note holders appear to be forcing more distressed loans into the marketplace. As a result, institutional investors, who were disappointed in the relatively slim pickings available in the distressed markets in 2009 and 2010, seem to be back on the hunt for more opportunities in investment-grade commercial real estate.

According to the latest CoStar Commercial Repeat-Sale Indices, transaction activity increased 24% from the first quarter of 2011 to second quarter of 2011. Investment grade transaction activity drove most of the increase. In March, CoStar Group forecast $45 billion to $60 billion worth of distress transactions in 2011.

The “extend and pretend” strategies through 2008-2010 moved a glut of loan maturities to this year. As of year-end 2010, CoStar forecasted more than $850 billion in commercial real estate loan maturities this year. And 2011 has produced a strong stream of newly delinquent loans on top of already significant increases in loan modification and liquidation activity.

Under such “extend and pretend” policies, lenders and servicers simply extended maturity dates as a way to wait out the Great Recession. Then in the second half of last year, the number of “true” modifications of principal and interest rate reductions began to make up an increased share of activity. This also opened the doors for banks to start releasing loans they did not want to modify back into the marketplace.

Many believe the new activity is the result of the of the significant amount of commercial real estate debt that is scheduled to mature over the next four years. Many of these properties have experienced deferred capital expenditures, which will require owners to invest additional equity or dispose of their assets.

Also contributing to the attractiveness of selectively acquiring commercial real estate is that, aside from a handful of high-end properties in top tier U.S. markets, commercial real estate values generally remain well below the pricing peaks reached during the 2005 to 2007 period. The CoStar report attributed this drag on commercial real estate to the downward pull exerted by sales of distressed properties.

The drop in values has put many otherwise healthy properties in a position where they will require infusions of additional equity so maturing mortgages can be refinanced. This gives new investors the opportunity to have a lower cost basis than those who bought similar properties a few years ago, providing them with the ability to offer lower rental rates than comparable properties with greater debt burdens.

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